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Tuesday, 10 May 2011

SHORT RUN :- Short run is a period of time in which a firm has some fixed costs which does not vary with the change in out put of the firm. The change only takes place in variable factors in the short period the number of firms remains the same in the industry.The firm sell the product at the prevailing price in the market. Because under perfect competition no single firm can affect the price of the market.

EQUILIBRIUM IN THE SHORT RUN :- A firm is in equilibrium at that point where Marginal Revenue (MR) = Marginal Cost (MC) and price.At this stage firm produces the best level of out put and it has no incentive to increase or decrease its out put. In the short run there are four conditions of equilibrium of firm.

1. ABNORMAL PROFIT OR MAXIMUM PROFIT CASE

Definition :- In the short run when the market price exceeds than the average total cost at the best level of out put a firm earn super normal profit.
It can be explained by the following diagram :

SATC = Short run average total cost
MC = Marginal cost
AVC = Average variable cost

Explanation :- In this diagram out put is measured along OX-axis and revenue / cost on OY. We assume that market price is equal to OP. A firm will sell the out put at OP price. A firm is in equilibrium at point "M" where MR = MC. The firm will produce OK out put and sell it at OP price. The total revenue of the firm is OPMK and total cost is ORNK. The abnormal profit is RPMN.

Note :- In this case all the firm in the industry are in equilibrium but the industry is not in equilibrium as there is a tendency for the new firms to enter into the industry to avail the maximum profit.

2. NORMAL PROFIT CASE

Definition :- Normal profit is the amount which must be paid to the owner of the firm to continue the business.

Explanation :- A firm is in equilibrium at the point "M". At this point MR = AR = MC = AC = Price. The firm produces OK out put and sells it at OP price of the market. The total cost is OPMK and total revenue is also OMPK. The firm is earning normal profit because OPMK = OPMK.

Note :- Normal profit is always included in total cost. All the firms and industry is in equilibrium at the OP price.

3. LOSS MINIMIZING CASE

Definition :- When the market price is smaller than the average total cost it is the loss minimizing position of a firm in the short run.

Explanation :- We assume that price in the market is OP. The firm is in equilibrium at point M where MR = MC. The best level of out put is OK which is sold at OP price. The total revenue is ORNK while the total cost is OPMK. T he loss is OPMK - ORNK = RPMN
These shows the loss of the firm and firm is covering the full variable cost and a part of the fixed cost.

4. SHUT DOWN CASE

Definition :- If the market price is smaller than average variable cost, it will be better for a one firm to close down the business to minimize the loss.

Explanation :- It is assumed that market price is OP. The firm is in equilibrium position at the point "M" where MC = MR. The firm sells OK out put but total cost is OPNK. The loss is OPNK - ORMK = RPNM.
So it will be better for a one firm to close down the business to minimize the loss. Because the firm is not even covering the average variable cost.

Any how we find that in the short run all the above conditions show the equilibrium of a firm.